RBI’s rate cut: Five possible outcomes on 18 June
The Reserve Bank of
India releases its mid-quarter monetary policy review on 18 June, and weakening
domestic and global economic conditions have added to the likelihood it will
take action to boost growth, despite lingering inflation worries.
On Thursday, the inflation was
reported to be at 7.55 percent in May, in line with expectations. However, the
GDP growth slipped to a nine-year low of 5.3 percent in the March quarter, and
industrial production was flat in May, data this week showed, adding to a sense
of urgency about the deteriorating state of the Indian economy.
A Reuter’s poll last week showed
most economists expect a repo rate cut, but few expected a cut in the cash
reserve ratio, the share of deposits that banks keep with RBI. Expectations
have grown since then for a CRR cut.
The RBI will release its
mid-quarter monetary policy review at 11am on Monday. Reuters
The RBI will release its
mid-quarter monetary policy review at 11am (0530 GMT) on Monday, and there is a
broader-than-usual range of expected outcomes, according to the predictions of
traders and economists.
Possible
scenarios:
25bps cut both in repo rate and CRR
Probability:
One of two most likely outcomes.
Many market participants are
betting on a modest reduction in both the repo rate and CRR because the
combination of interest rate and liquidity easing would send a signal that the
RBI is keen to prop up growth by providing liquidity to banks while ensuring
inflation is under control. An easing in core inflation to around 4.85 percent
in May may give the central bank comfort to cut rates.
Such an action would compel banks
to cut lending rates as improved cash flow brings down their cost of deposits,
which has remained high despite the RBI’s previous rate and CRR cuts. The
market also expects the RBI to sound pro-growth in its statement, and at the
same time highlight inflation risks.
Market
reaction: The government bond yields and interest rate swaps could
ease 5-7 basis points and the curves may shift downwards. The rupee may rise
marginally, with stocks posting modest gains.
25 bps cut in repo rate, no CRR cut
Probability:
One of two most likely outcomes
The RBI may decide only to reduce
rates but refrain from infusing more market liquidity, as it is already
injecting cash into the system through bond purchases and may prefer to save
the CRR tool for when liquidity tightens sharply. High food prices and consumer
price inflation continue to pose risks to inflation and the RBI may not be
comfortable turning dovish.
However, only a repo rate cut may
not be enough to spur banks to cut lending rates, or to improve sentiment
sufficiently to bolster growth.
Market
reaction: Given that markets have already priced in a 25 basis point
rate cut, such a mild step could disappoint investors and push up bond and swap
rates.
No repo rate cut, 50bps cut in CRR
Probability:
Less likely
To improve monetary policy
transmission, the RBI could choose only to reduce the CRR, which would release
liquidity and bring down banks’ cost of funds immediately, enabling them to
reduce lending rates. Many view a reduction in CRR as a more effective tool
than a rate cut.
The central bank has been under
increasing pressure to cut the CRR after finance ministry officials and the
country’s largest state bank have called for one.
The RBI may be reluctant to cut
CRR by such a big margin, however, that could fuel inflationary pressures.
Market
reaction: The government bond and swap curves could steepen with
short-end rates softening as cash pressures ease. Concerns that a steep CRR cut
could prompt the RBI to avoid bond purchases could keep long-end rates
elevated.
25bps cut in repo rate, 50bps cut in CRR
Probability:
Less likely
Some investors hope the RBI turns
actively dovish, betting that a big CRR cut accompanied by a rate cut ensures
effective monetary policy transmission. With mounting pressure on the RBI from
the government, some in the market believe the RBI may take the plunge and
release an aggressively pro-growth policy.
Market
reaction: Short-end government bonds and swap rates would ease more
than the long-end. The rupee and stocks could post gains.
No change in rates or CRR
Probability:
Unlikely
With a sagging economic growth,
moderate core inflation, and increasing pressure from the government, it is
unlikely that the RBI does nothing, as a downturn in domestic and global
economic conditions has spurred calls for central bank action. Until a few
weeks ago, the majority view was that the RBI would keep rates and CRR on hold
at its June review.
Market
reaction: There would be sharp sell off across all asset classes.
